Current outlook and portfolio strategy | News, Sports, Jobs – SANIBEL-CAPTIVA
A lot has happened across the world in the first few months of the new year. As global economies headed towards normalcy as the Omicron Variant began to fade, geopolitics took center stage. Russia invaded Ukraine on February 24, creating a humanitarian crisis on a scale not seen in Europe since World War II. The war caused several hundred global companies to pull out of Russia. NATO members have imposed deep economic sanctions on Russia, heightening inflation concerns, especially in energy and grain markets where Russia is a key contributor. This turmoil has certainly had an impact on capital market volatility, which is likely to continue until a peaceful solution is found.
Geopolitics aside, we entered 2022 with other economic concerns already front and center. Year-on-year inflation figures were at their highest level in 40 years before the start of the Russian-Ukrainian conflict. To combat inflationary pressures, the Federal Reserve has reduced its bond purchases for several months, while signaling that interest rate hikes would follow. On March 16, the Fed raised the federal funds rate for the first time since the start of the COVID-19 pandemic. Moreover, much of the fiscal stimulus discussed by Congress last year was shelved due to inflationary concerns expressed by both political parties. More restrictive (less accommodative) monetary and fiscal policies aim to reduce the rate of price increases and the corresponding erosion of purchasing power. To be clear, most economists believe that inflation of around 2% per year is both sustainable and healthy for our economy. However, most economists also believe that our current level of inflation (7% to 8%) is detrimental, especially for low-income consumers.
The Fed certainly has the tools to curb inflation. A steady increase in the federal funds rate is one such tool. Following the last Fed meeting, we expect six more rate hikes between this year and next year. Interestingly, the rest of the Treasury yield curve began to adjust to the likelihood of higher rates months ago. Longer-term interest rates have already risen significantly and corresponding bond prices have fallen. If the Fed decides to be even more aggressive, it can sell fixed income assets off its own balance sheet, which would also lower bond prices, raise yields and dampen credit markets and inflationary pressures. A successful tightening cycle will be characterized by higher interest rates, lower inflation, and sustained consumer spending and economic growth. The correct mix, scale and timing of Fed policy decisions is key to this success and is a hotly debated topic among economists for good reason.
Despite the risks mentioned above, there is cause for optimism. Although stock markets tend to be more volatile when interest rate policy changes, equities tend to do quite well when interest rates rise, as investors initially view rising rates as the symptoms of a healthy economy. However, valuation certainly matters more when rates rise, which is why it’s important to be an informed investor. Despite the short-term risks of inflation and geopolitical conflict, our economy remains healthy overall. While we continue to believe that value-oriented, dividend-paying companies offer slightly better long-term return prospects than many of their growth counterparts, a combination of the two is important in a well-balanced portfolio. For those looking for fixed income securities (bonds) to reduce risk, we continue to favor higher quality bonds with shorter maturities as interest rates rise. As always, we will continue to focus on finding and managing high quality investments, with valuation at the forefront of investment decision-making.
Ian N. Breusch is the Chief Operating Officer of The Sanibel Captiva Trust Company.